The Russian Supreme Court on a tax benefit for movable property

Despite the literal wording of article 381(25) of the Russian Tax Code, movable property that was acquired from a related party can be exempted from taxation in certain cases, according to the Russian Supreme Court.

The Judicial Board for Economic Disputes of the Russian Supreme Court (the “Court”) considered the case against JSC Novomoskovsk Joint-Stock Company Azot (the “Company”).

It follows from the case files that:

• the Company acquired from a related company a product (it was booked on the seller’s accounts as a product, i.e. there was no taxable item), which was produced by the related party after 1 January 2013, mounted it and booked it as a fixed asset;
• although article 381(25) of the Russian Tax Code (the “Tax Code”) stipulates that a property tax benefit cannot be applied if the property is acquired from a related party, the Company proceeded on the assumption that the above restriction was not applicable in its case;
• the taxpayer argued that the restrictions in applying the benefit stipulated by article 381(25) of the Tax Code emerge when a related party that is a seller was obliged to pay the tax and such an obligation is terminated for another related party that is the buyer as a result of a transaction to transfer the property (the property under the transaction was booked after 1 January 2013);
• the tax authority and the state commercial courts disagreed with the above approach, relying on the fact that article 381(25) of the Tax Code literally does not provide for any exemption from property tax when such property is acquired from a related party.

Conclusions of the Court

1. The Court indicated as follows:

• The Company lawfully applied the tax benefit;
• indeed, it can be concluded from a literal interpretation of the provisions of article 381(25) of the Tax Code that property that was obtained and registered after 1 January 2013 as a result of a transaction with a related party should be taxed in any case, and only property obtained from a non-related party after the above date will be tax exempt;
• yet, the rule of law (even when it has a rather clear wording and does not contain any ambiguity) should be interpreted taking into account the objectives behind the adoption of such rule as well as the general taxation principles;
• the objective behind introducing the tax benefit exempting property that was registered after 1 January 2013 was to encourage the replacement of fixed assets;
• the restrictions on the benefit which came into effect starting from 2015 were aimed at preventing an abuse by taxpayers who are related parties and who have the opportunity to obtain an unjustified tax benefit by transferring within a group property that was produced before 1 January 2013;
• therefore, when the related party that was the seller did not accrue the obligation to pay property tax (it was booked in the accounts as a product and was produced after 1 January 2013), there was no abuse of rights to the benefit, and the objective of the tax exemption (the replacement of fixed assets) was attained;
• otherwise related parties are put in an unequal position as compared with transactions between non-related parties given that the transactions are identical in economic terms. This runs counter to the fundamental taxation principles that are established by article 3 of the Tax Code (equality, non-discrimination and the economic substance of taxation).

2. We should note that, on the whole, the judgment issued by the Court is rather favourable for taxpayers and differs from other judgments in terms of the scale of issues raised.

General conclusions

1. As the situation in dispute reflects, the seller in any case should not have paid property tax because (a) it did not have any fixed assets (the assets were products); and (b) the property was produced after 1 January 2013.

The conclusions of the Court’s Judicial Board for Economic Disputes regarding the possibility of what is referred to as a ‘broad’ interpretation of the tax law can be extended to other cases when the benefit under consideration was refused. For example, with respect to property that was produced before 1 January 2013 if the seller within the group had not been obliged to pay the tax on other grounds (the property was booked as a product, a tax exemption is granted by regional and local authorities, etc.).

If we take the logic of the Court further, a conclusion can be drawn that the right to the benefit should be restricted only if an abuse by the group is established in a situation that was artificiality created when property is transferred into a category of property that is subject to exemption. If there is no such circumstance (the seller had not paid the tax on legal grounds), the property should be exempted from the tax.

With such logic being applied, the question arises of whether the restrictions established in article 381(25) of the Tax Code are consistent with the Russian Constitution. By presuming that taxpayers must not abuse their rights the law has restricted the rights even of those taxpayers who honestly applied the benefit (had a business purpose in concluding the transaction). It is evident that the positions set out in Resolution No. 53 of the Plenum of the Supreme Commercial Court dated 12 October 2006 (“Resolution No. 53”) and in article 54.1 of the Tax Code were sufficient to replace the above restrictions.

2. Article 381(25) of the Tax Code is being repealed with effect from 1 January 2019. Nevertheless, the Court’s Ruling contains conclusions that can be extended to other topical issues that arise in tax disputes:

a) the Court reminded the enforcing authority that the literal interpretation is not the only one, nor is it the main one. Considering the above, it seems reasonable to again look into the matters when the practice of a literal interpretation has prevailed, specifically:

• what is meant by ‘exclusively’ leasing operations for the purpose of an increased coefficient of thin capitalisation rules being applied under article 269(2) of the Tax Code – only income in the form of leasing payments or other income related to such operations (this is relevant for both before 1 January 2017 when a previous version of the article was in effect and stipulated that ‘exclusively’ leasing operations should have been performed, and after that date, for the question remains of what should be treated as income from leasing operations);
• is it really the case that, based on the purposes of statutory regulation, thin capitalisation rules should be applied even in cases when it has been established that an independent company would have issued a loan to the company of the group on the same conditions as the related-party lender had done.

b) developing the logic of Resolution No. 53, the Court’s Judicial Board for Economic Disputes also pointed out that the aggregate of the tax consequences for the whole group of companies should be assessed when a tax benefit for a single company of the group is assessed.

What to think about and what to do

The judgment issued by the Court can be taken into account by taxpayers when they calculate the amount of tax for 2018.

If the taxpayer previously refused to apply the benefit under 381(25) of the Tax Code, an adjusted tax return and an application for the refund of the overpaid tax can be filed within three years after such overpayment.

Help from your adviser

Pepeliaev Group’s lawyers are ready to help you to determine whether a tax benefit has been lawfully applied not only in the identical situation but also in other cases when property is obtained from a related company, as a result of reorganisation or liquidation, when the tax is assessed for the current year and is reassessed for previous years to determine whether any overpayment can be refunded. We are also ready to provide services involving legal support in having tax overpayments refunded, including through administrative and judicial proceedings.